US midterm elections

First, what exactly are the midterms? Halfway through a presidential term, voters elect members of the House of Representatives and the Senate, which together form Congress. Congress debates and votes on legislation. The party that controls a majority in Congress can therefore exert greater influence over policy. At present, the Republicans hold a majority in both the House of Representatives and the Senate.

Trump is trying to attract Republican voters by focusing on strong economic growth and corporate profits. Historically, however, the midterms have primarily served as a referendum on the president’s popularity. President Trump is currently polling very poorly (see chart below), largely because inflation has remained above the central bank’s target for years and American consumers are feeling the financial effects of the Iran war. As a result, Democrats are likely to make gains. For more background, see ABN AMRO Group Economics’ recent article on the US midterm elections.

For investors, however, it is important to put the elections in perspective. We expect the ultimate economic and financial impact of the outcome to be limited. Through executive orders and veto power, Trump will retain significant control regardless of the midterm results. Consequently, the effects on equities and bond yields are likely to be far smaller than political headlines suggest. That said, a Congress controlled by Democrats could create more resistance and slow down Republican policies.

A divided Congress would primarily result in ‘gridlock’, meaning a political stalemate. Passing major new legislation would become more difficult, meaning the current policy direction would largely remain intact. Laws that have already been passed but only take effect after the midterms, such as the cost-saving measures in the ‘Big Beautiful Bill’ (Trump’s tax and budget legislation), would continue as planned. Trump would retain his executive powers and could continue governing through executive orders, although Congress might exercise somewhat greater oversight.

For bond yields, this would likely be the most neutral scenario. A lower probability of major new fiscal initiatives would limit upward pressure on long-term yields, but it would also leave existing fiscal challenges unresolved. In this scenario, bond investors would primarily return their focus to fundamental factors influencing the US Treasury market.

For equities, the impact would be limited. Uncertainty about future policy would decline somewhat, as new policies become harder to implement and existing policies become more difficult to reverse. Investors tend to appreciate this predictability and stability because it reduces the need to focus on politics. Instead, they can focus on corporate profitability – which is currently strong.

The most significant political shift would occur if Democrats gained a majority in both chambers of Congress. The Trump administration would then face considerably greater congressional oversight. Democrats would gain more opportunities to hold hearings, launch investigations, and delay appointments. However, much of the Democratic policy agenda would remain difficult to implement while Trump remains president. Through the presidential veto, Trump can block legislation, while executive orders allow him to continue pursuing his own agenda.

Political uncertainty surrounding the debt ceiling and government funding would increase, raising the likelihood of another government shutdown when the debt ceiling is reached again. Democratic pressure would also reduce the scope for fiscal expansion[1]. The likelihood of new fiscal initiatives would decline. There would still be upward pressure on yields due to the current large budget deficit, but less so than in the other two scenarios. This would therefore be the most favourable scenario for bond prices (bond yields move inversely to bond prices).

For equity markets, the uncertainty created by a Democratic victory could initially lead to greater volatility. The risk of regulatory changes and the prospect of increased political confrontation could weigh on investor sentiment. In addition, Congress would place greater emphasis on renewable energy, infrastructure, and healthcare, sectors that could benefit as a result. On the other hand, this scenario would be less favourable for fossil fuel companies and financials. Permits for new data centres could also face delays. Nevertheless, earnings growth, economic growth, and interest rate levels remain more important drivers of market performance.

A Republican victory would effectively represent the status quo and would give Trump the greatest freedom to continue his existing agenda. Further deregulation and new fiscal measures would be easiest to implement under this scenario. Whether that would actually happen remains uncertain, as Trump appears to have already implemented most of his plans during the first half of his term. This scenario would nevertheless result in the largest budget deficit of the three scenarios, which could lead to higher yields and lower bond prices.

For equities, a Republican victory could be interpreted positively, as the business environment would remain favourable. Lower taxes, expansive fiscal policy, and deregulation would remain intact. This policy mix would particularly benefit fossil fuel companies, financials, and defence companies, while renewable energy would continue to face pressure.

Although the midterms receive significant media attention, we expect their impact on markets to remain fairly limited. Trump has already implemented most of his policy agenda and can continue governing through executive orders and vetoes where necessary. In short, the midterm elections matter more to Washington than to Wall Street.

For investors, the key is to maintain a well-diversified portfolio and stay focused on corporate earnings and economic growth. Both are currently strong.